Nasscom says U.S. companies will lose out, as Japan and Europe plan to tax only profits earned within their borders

India's National Association of Software and Service Companies (Nasscom) said Tuesday that the move by U.S. President Barack Obama to modify the tax code to make profits earned abroad by U.S. companies taxable in the United States, will end up reducing the competitiveness of U.S. companies with global operations, when compared to their European and Japanese counterparts.

Describing the current U.S. tax system as "broken," Obama said Monday it's a tax code "that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York."

The way to make U.S. companies remain the most competitive in the world is not to reward companies for moving jobs offshore or transferring profits to overseas tax havens, Obama added.

The U.S. direction is contrary to that of Japan and Europe, which are moving to a territorial system that taxes only corporate profits earned within their borders, Nasscom said.

Current U.S. law mandates that any income earned outside the United States is not taxed until it is brought back into the country. Obama aims to alter that in order to raise the government revenue, Nasscom said.

The Obama's remarks come even as Indian outsourcers are facing a sharp contraction in business because of the global economic downturn.

U.S. companies like Cisco, Dell, IBM, Hewlett-Packard, and Microsoft run software development and services subsidiaries in India. But a number of them also use Indian providers for some of the work.

Obama discussed taxing corporate profits earned outside the United States, but did not speak about measures to curb outsourcing to third parties. Indian companies are the main beneficiaries of that practice.

Obama's proposal aims to close corporate tax loopholes on U.S. multinational companies and crack down on their overseas tax havens, India's second largest outsourcer, Infosys Technologies said in a statement Tuesday.

Infosys said it did not believe that the new proposal had anything to do with IT outsourcing by U.S. companies.

Analysts however said that the new tax code will include deterrents to outsourcing to Indian companies.

"If the objective of the changes to the tax code is to protect jobs in the United States, then there will be provisions in the tax code to offer disincentives to outsourcing as well," said Siddharth Pai, a partner at outsourcing consultancy firm Technology Partners International in Houston.

The economics of outsourcing to low-cost locations like India are too compelling to be affected by a change in the tax code, Pai said.

Companies are setting up software and services operations in countries like India, or outsourcing to local providers, because it is not easy to find talent in sufficient numbers in the United States, he added.

India has a young population, while the United States has an aging population, and these demographics work in India's favor on the outsourcing front, Pai said.

Indian outsourcing companies have typically held that outsourcing to the country increases the competitiveness of U.S. companies, and will ultimately help create jobs in the United States.